A decade ago, the U.S. Supreme Court’s ruling in MedImmune LLC v. Genentech Inc. permitted patent licensees to seek declaratory judgments of patent invalidity, unenforceability or noninfringement without first terminating or breaching the license agreement. Prior to MedImmune, in order to challenge a patent, the patent holder had to cease paying royalties and put itself in breach of the license. This left the licensee facing the dilemma of whether to continue paying royalties for an invalid patent or risk termination of a license for a valid patent. Since MedImmune, other appellate court decisions have raised the bar for patent validity, increasing the risk that licensees will challenge patents.
In the 10 years following MedImmune, patent holders have taken into account the increased risk of a subsequent patent challenge by including provisions in license agreements that are a disincentive to the licensee challenging the validity of the licensed patent. These have ranged from termination clauses to royalty adjustment provisions and other contractual provisions designed to level the “playing field” or, in some cases, tilt it in favor of the patent holder. While these provisions are often negotiated, they are rarely eliminated. Regardless of the provision, the question as to the enforceability of such provisions remains. In Lear Inc. v. Adkins, the U.S. Supreme Court stated the policy against which the validity of these provisions is tested.
[T]the equities of the licensor do not weigh very heavily when they are balanced against the important public interest in permitting full and free competition in the use of ideas which are in reality a part of the public domain. Licensees may often be the only individuals with enough economic incentive to challenge the patentability of an inventor’s discovery. If they are muzzled, the public may continually be required to pay tribute to would-be monopolists without need or justification. We think it plain that the technical requirements of contract doctrine must give way before the demands of the public interest in the typical situation involving the negotiation of a license after a patent has issued.
Therefore, the validity of any restrictive contract provision in a license that limits the ability of a licensee to challenge a patent must be considered in light of such policy. This article examines how patent holders and their licensees have responded to MedImmune in drafting and negotiating license agreements, and the nature of some of the patent challenge clauses.
Patent Challenge Clauses
Each patent challenge clause typically is structured in two parts: the first being the definition of a patent challenge and the second being the remedies available to the patent holder conditioned upon the occurrence a patent challenge.
Patent Challenge Definition
The definition of what constitutes a challenge to the validity or enforceability of a patent varies from license to license. The following are three examples from license agreements prepared by a major university or research institution.
In its simplest form, the clause states that “if licensee or its affiliate under a license commences an action in which it challenges the validity, enforceability or scope of any of the patent rights under, then [a remedy will be triggered, such as termination of the license, doubling of the royalty rate, or some other event].” Parties negotiating such a provision should consider whether the reference to challenging the “scope” of the patent may result in triggering the remedy if the licensee disputes whether a product infringes, or falls under, a licensed patent, which the licensee should be free to do regardless of the outcome of negotiations on this clause.
Another version of the patent challenge definition that encompasses a broader range of activities is a clause that provides “in the event any licensee (or sublicensee or any entity or person acting on its behalf) initiates any proceeding or otherwise asserts any claim challenging the validity or enforceability of any licensed patent right in any court, administrative agency or other forum, then [a remedy will be triggered].” One of the issues with this provision that the terms “or otherwise asserts any claim” alone or when taken in conjunction with “other forum” could cause a fact finder to determine that some action other than a legal proceeding might result in a breach of the license, for example, a mere claim or threat made by the licensee without resorting to a legal proceeding.
An even broader patent challenge clause triggers the penalty as a result of “any legal or administrative challenge to the validity, patentability, enforceability and/or non-infringement of any of the licensed patent or otherwise opposing the licensed patent.” This type of clause presents a number of problems. First, this provision clearly states that the remedy is triggered if the licensee disputes whether another product which it manufactures or sells infringes a licensed patent, even if the licensee does not challenge the validity or unenforceability of the patent. Second, the words “opposing any licensed patent” is also broad and ambiguous such that any dispute about a licensed patent may be encompassed by this phrase, even if the licensee’s dispute not rise to an assertion that a licensed patent is not valid or enforceable. A licensee, however, should be free to assert that a product or service does not infringe a patent and therefore no royalties are owed, without triggering a remedy clause.
Finally, certain clauses define a patent challenge to include not only the actions of a licensee but also the action of a sublicensee or even a third party. In such cases, the definition may include a provision where assisting third parties in bringing a patent challenge triggers the remedy. Unless the provision is eliminated, it is important to ensure that the provision excludes situations where the licensee is required to involuntarily assist a third party, such as pursuant to a civil subpoena, government investigation, or other similar situations.
Once a patent challenge has occurred (as defined by that clause), then one or more remedies may be triggered. The following are some options and recommendations for patent holders.
Right to Terminate the License vs. No-Challenge Clauses
A common remedy in a patent challenge clause is the patent holder’s right to terminate the license if the licensee challenges the licensed patent. There are concerns as to whether such a right is enforceable as this right has not been fully tested and may run counter to the policies announced in MedImmune by allowing the license to be terminated, potentially creating a draconian result for the licensee. It is important to distinguish termination rights against so-called “no challenge clauses” where the license has agreed not to challenge the validity of the patent while a license is in force.
In Lear, the U.S. Supreme Court held that a licensee under patent license is not “estopped” from challenging the validity of the licensed patent, reversing the prior rule of licensee estoppel. The invalidation of the principal of licensee estoppel in Lear has been extended to invalidate no challenge clauses. As stated in Rates Technology Inc. v. Speakeasy Inc., “[i]f no-challenge clauses in pre-litigation agreements were held to be valid and enforceable, Lear's strong policy ‘favoring the full and free use of ideas in the public domain’ could be evaded through the simple expedient of clever draftsmanship.” It remains unsettled, however, whether a clause which provides the patent holder with the option to terminate a license upon a patent challenge is valid. Commentators have suggested that such clauses should be valid because unlike the no challenge clause, a termination clause does not prevent the licensee from challenging the validity of the licensed patent. While courts have rarely addressed this clause, it remains an option that may be enforceable and should be considered.
Increase in Royalty Rates; Liquidated Damages
Increasing the royalty rate during and/or after the pendency of a patent challenge proceeding is a common provision. The argument frequently made as to why a royalty rate would be increased (typically doubled or trebled) following a successful defense of the patent in a patent challenge is that, having withstood the challenge, the patent is stronger and therefore more valuable. Such an approach appears at least on its face to be supported by some case law, providing that the calculation of a royalty before and after a patent has been ruled valid takes into consideration different economic factors then before the patent is ruled valid. Finally, licensors may find it useful to provide that if the outcome of the patent challenge proceeding is a determination in favor of the licensee, then the licensee will have no right to recoup any royalties paid before or during the pendency of such patent challenge proceeding. An alternative to an increase in a royalty rate might be a liquidated damages clause following a successful challenge. While a liquidated damages clause was struck down by the court in Rates, it was in connection with a no challenge clause, which may leave room for a more narrowly tailored liquidated damages clause.
Reimbursement of Legal Fees
Another common provision in response to MedImmune requires that the licensee reimburse the patent holder for all expenses incurred by patent holder (including reasonable attorneys’ fees) in connection with a patent challenge proceeding. Sometimes this provides for reimbursement only upon the successful conclusion of the patent challenge proceeding in favor of the patent holder; however, sometimes it provides for reimbursement without regard to the success of the defense to the proceeding but on an as incurred basis. For organizations with insufficient funds to fight a patent challenge, such as a public university or small biotechnology company, the reimbursement of all legal fees may be very important to make sure the patent holder has the resources to defend against a patent challenge.
Upfront Royalty Payments
Another strategy for licensors to reduce the risk of loss of royalties from a patent challenge is to increase the amount of royalties paid upfront instead of a running royalty, thereby lowering the amount of the loss if there were a successful patent challenge. A “belt and suspenders” approach to this position would be to include a provision whereby the parties agree that if the licensee is successful on a challenge it has no right to recoup royalties or fees previously paid.
Notice of Patent Challenge
A provision in a license requiring prior written notice to the patent holder if a licensee is considering a patent challenge may be another strategy to mitigate the risk of a patent challenge. By requiring a licensee to provide notice of a patent challenge along with a full disclosure of the basis for the challenge, the patent holder may be better prepared to defend a potential patent challenge. Furthermore, such a notice may encourage settlement rather than a initiating a proceeding or litigation. This provision also may be very important where the patent holder has delegated to the licensee the right to control prosecution of the patent with its own attorneys.
Finally, although not strictly a defense, in a recent proceeding before the Patent Trial and Appeal Board at the U.S. Patent and Trademark Office, Covidien LP v. University of Florida (case numbers IPR2016-01274, IPR 01275, and IPR2016-01276), the PTAB held that sovereign immunity applies to state university patent owners as a defense to a request for inter partes review under the America Invents Act. A licensee may want to insert a waiver of sovereign immunity in any license agreement with a state or federal government entity to counteract the effects of this case.
Effect on Acquisitions
It is important to remember that a licensee may be acquired by a third party that may be considering or already have challenged a patent subject to the license. Such an event could prevent the acquisition from being consummated or lead to large escrows depending on the value of the license to the buyer. A provision permitting the acquisition to occur without violating the license should be addressed in any license if possible.
Patent holders’ efforts to protect their patent positions and the revenues associated with the patents have led to the development of contractual provisions to attempt to dissuade a licensee from challenging the validity or enforceability of a patent. It is important for a licensee to pay close attention to these clauses and their effect and for both parties to be attentive to cases, which may affect the validity of these clauses.
Reprinted with permission of Law360.